Healthcare conversations over the past two years have centered almost exclusively on COVID-19, vaccinations, and therapeutics. Yet the dynamic sector offers much more to dissect as we emerge from the pandemic.
This year, investors have flocked to healthcare stocks in search of safe-haven assets that tend to offer consistent revenue streams amid global uncertainty. Healthcare was a cornerstone of Mark Newton’s 2022 strategy, along with Energy, and we believe there are quality stocks in the sector worth considering for your portfolio. Many names in the space also boast respectable dividends.
Newton, our Head of Technical Strategy, remains constructive on Healthcare, as well as Brian Rauscher, our Head of Global Portfolio Strategy and Asset Allocation, and Adam Gould, our Head of Quantitative Strategy, who recently noted his models continue to show the area is promising. “I’m positive on Healthcare right now,” Gould noted last week. “Certainly, from a defensive standpoint, I prefer it to staples.” And, as you’ll find, below, Tom Lee, our Head of Research, added several healthcare names to his Granny Shots list, which has beaten the S&P 500 by 96% since inception. In this piece, we will offer analysis on each of his recent picks.
For investors looking for a defensive bent, Healthcare might be the place to be; it is less correlated to the business cycle than more cyclical sectors, largely because of the outsized role of government spending and heavy regulation. Healthcare companies provide steady returns in any market. People will always pay for Healthcare, so the sector’s returns are usually relatively uncorrelated with the overall direction of the stock market. This year, for example, the Healthcare ETF ($XLV) is down only about 5% compared with the S&P 500’s 15% pullback. For years, Healthcare has been considered one of the most reliable defensive sectors, an effective buffer when markets turn volatile. Hospitals, drug makers, medical device firms, and other companies across the sector benefit from steady demand, regardless of the economic environment. In a recession, for example, we still need cancer drugs and vaccines.
Further, the sector is growing at a relatively fast clip. National health spending is projected to grow at an annual rate of 5.4% through 2028, and Deloitte estimates that U.S. health spending will balloon from 2020’s $4 trillion to $8.3 trillion by 2040. Technological advances, an aging population, and improving treatments for chronic diseases and conditions are all bullish long-term catalysts.
Our view is that one of the legacies of the pandemic is a timely catalyst to accelerate emerging opportunities in the Healthcare sector, including new drugs, vaccines, and therapeutics, as well as improved services for mental health and well-being. The pandemic exacerbated growing rates of mental illness, depression, anxiety, fatigue, and burnout. Consider:
· U.S. obesity is swelling. From 1999 through 2020, U.S. obesity prevalence increased from 30.5% to 41.9%, according to the CDC
· 2022 marks the second full year of the COVID-19 pandemic, and it continues to dominate health systems’ attention and resources, with the global death toll over 5 million
· As a result, U.S. life expectancy has now fallen by nearly two years – the sharpest single year decline since World War II
· Soaring rates of social isolation and depression/anxiety threaten not only our physical and mental health but the health of our democracies. Hence, the demand for ways to mitigate isolation and prioritize well-being
One of Newton’s top picks this year was Healthcare, which experienced a big uptick in relative performance to finish 2021. Many pharmaceutical companies broke out to new all-time highs. Newton wrote in his 2022 strategy, “while Biotech remains a work in progress, this group should outperform this year, and Pharma, Medical Devices are subgroups to overweight.”
This week, Newton cautioned that the relative breakout of $RYH, the Equal-weighted Healthcare ETF vs. SPX, “hasn’t resulted in as much upward acceleration as Healthcare bulls would like to see,” adding, “Starting in mid-June, when U.S. Stock indices bottomed, we saw a meaningful shift in sub-sector rotation and Biotech and Services names started to show better performance. Some of this was due to the small-cap nature of the composition in popular ETF’s like XBI as Treasury yields fell sharply. Stocks such as $MCK, $VRTX, $CI, and $CNC have caught up quickly in the last month.”
But Newton’s work shows that, for investors with a horizon of several months, Healthcare looks primed to outperform in the second half given its relative breakout vs. SPX and subsequent consolidation. He added: “I suspect that Biotech stocks likely show better overall performance in the back half of 2022 following a difficult first six months. Overall, technically it’s right to remain bullish on Healthcare, but simply watch as the sub-sector swaps show a rapid rotation between defensive and risk-on positioning, directly coinciding with U.S. stock index performance.”
In addition, while the Healthcare sector has been slow to embrace technological change, the momentum is beginning to shift. Whether the sector has been slow to embrace change or whether heavy regulation makes technological adoption slower is a critical question. Digitization of medical records is slow, but other areas such as the speed of turning around a Moderna vaccine are exemplary. Pandemic exigency helped clear the way for technological advancement like DexCom’s use of continuous glucose monitors in hospitals. This would suggest that regulation is a primary impediment to change in this case, other cases might suggest differently.”
We should see progress in areas such as precision surgical tools and minimally invasive procedures, as well as the growing trend of wearable tech and connected devices such as continuous glucose monitoring systems. Some longer-term investors believe Healthcare stocks will continue to surge as baby boomers grow older, which necessitates new drugs, diagnostics, and medical technologies.
The Healthcare sector is one of the largest and most complex in the U.S. economy, accounting for 18% of gross domestic product (GDP) in 2020, which is much higher than most of the developed world. The U.S. Healthcare system is marked by private insurance being the primary provider, and the significant market force of Medicare/U.S. government is part of what makes Healthcare less-cyclical than other sections. It also is a non-seasonal necessity, and the sector benefits from a strong system of medical research and development, in cooperation with the higher education system and the technology industry. (While there are some exciting forays by Tech into Healthcare, the R&D infrastructure is still distinct and separate.)
Investing in the sector doesn’t come without risk. The sector accounts for an outsized share of spending relative to health outcomes, which has led to uncertainties around politically driven reform of the industry. The rising costs of U.S. Healthcare might be unsustainable. Payers and patients are demanding better care at lower prices. Also, tech companies are involved in the sector more than ever before, such as Amazon and Apple. Both Tech Generals have ambitious plans to grow.
Depending on the outcome of the midterm elections, Healthcare companies could come under more scrutiny from regulators and politicians. If Republicans win control of the House and Senate, there could be questions about the future of the Affordable Care Act (Obamacare) and what that could mean for drug prices, though Tom Block, our Washington Policy Strategist, notes that until 2025, President Biden will be in place to veto bills. Said Block: “So, I don’t think much would become law,” a view in line with many strategists. It’s also worth noting that a Democratic bill calls for letting Medicare negotiate the price of some prescription drugs.
In addition, many Healthcare stocks also face significant litigation risk. For example, biopharmaceutical companies, medical device makers, and Healthcare providers can be sued if patients think the companies’ products and services have caused them harm.
Below, we bring analysis of all five of Lee’s new Granny Shots that fall under the Healthcare umbrella:
Moderna ($MRNA, Biotechnology)
After the pandemic-induced global shutdown, the pharmaceutical industry was called on to provide relief to the overwhelmed health care sector in the form of a vaccine. Moderna answered that call after the FDA passed emergency authorization of its COVID-19 vaccine, Spikevax, on 12/18/2020. In 2021, the company delivered 824 million vaccines globally as COVID-19 cases soared, and its stock price followed accordingly.
In early 2022 (as shown in the red box above), cases rose both in the U.S. and globally, but MRNA stock gave up over half its gains. Given the recent valuation compression, we are in the camp that today marks an opportunity to begin accumulating shares of MRNA. Given the company’s future opportunity to capitalize on mRNA science and the recurring impact on revenue as overwhelming evidence suggests that COVID-19 will become endemic, we believe investors will look back on today as an opportunity to have bought rather than sold MRNA.
Moderna currently trades at a modest 6.95x forward earnings that is based on estimates that have already come down considerably. The company is free cash flow-generative (20.01% free cash flow yield) and currently supports a strong economic moat considering it is only one of few pharmaceutical companies to have developed a globally distributed vaccine for the Coronavirus. While scientists remain unsure of the exact seasonality of illness associated with COVID-19, secular tailwinds persist for Moderna as overwhelming evidence is suggesting that the virus will become endemic. This should provide long-term revenue recurrence for the company as governments will continue to purchase Moderna’s vaccine, Spikevax, to combat the virus’ spread. The COVID-19 pandemic also gave Moderna the opportunity to expand its geographic revenue as its vaccine was distributed globally. In 2021, revenue composition by geographic region was 37.1% from Europe, 33.4% from the United States, and the remaining ~1/3 of revenue was spread out across its “Rest Of World” segment.
The main risk that investors associate with Moderna is that it will crumble in a post-pandemic world. The company’s Q2-22 earnings, instead, suggest that the company will continue to thrive as a manufacturer of mRNA-based vaccines and tackle global health threats as they surface. Looking at one of Moderna’s competitors, Pfizer-BioNTech, the company is currently developing a cancer vaccine for Advanced Melanoma. Moderna has this optionality in its development given how advanced it is within the mRNA complex and we view the opportunity as a constant tailwind for the company.
Biogen ($BIIB, Biotechnology)
While the past year has been a slow and steady decline for Biogen, we see daylight ahead for the stock. It looks to be turning a corner and trending upward. With their focus being the “pioneers of neuroscience”, Biogen focuses primarily on disease thought to be incurable. From Alzheimer’s to Parkinson’s, Biogen aims to use neuroscience to develop medicines and benefit society. In the most recent earnings release, Biogen came out with earnings at $5.25 per share, beating the estimate of $4.07 by roughly 28%. Of the past four EPS vs. estimate, Biogen has come out on top three out of four times. Simply put, they have been outperforming what has been expected of them.
Recently, with the leading Alzheimer’s disease drug, Aduhelm, being written off, the company has decided to change directions by changing CEO’s. Michel Vounatsos, current CEO, will continue to hold the CEO position until his successor is chosen, where he will then step down from the role. Following Aduhelm being written off, the focus has shifted to the treatment issued by Biogen called Toferson. However, in recent trials there have been some speed bumps. In the most recent trials, Biogen’s drug failed to meet its primary goal of slowing functional decline in a late-stage clinical trial. Despite the failure, the FDA is still considering the drug for a rare form of ALS known as SOD1. Speaking on the importance of the drug, Dr. Priya Singhal, Biogen’s interim head of research and development, said, “If approved, Tofersen will be the first treatment to target a genetic cause of ALS, and we hope this will pave the way for further advances in this relentless disease.”
Biogen has planned an “educational blitz” to overcome hesitation about their drug, Byooviz. Byooviz is an anti-vascular endothelial growth factor (VEGF) drug that has been FDA approved. Selling at 9% less than its main market competitor, Lucentis, Biogen is aiming to aid the process of removing the hesitation of Byooviz and increase the drug’s rank among competitors. Another Biogen drug, Lecanemab, will have its Phase III data available in the fall. Lecanamab is an experimental drug in clinical trials for the treatment of Alzheimer’s disease. The release of the Phase III data will be a key catalyst for Biogen in the coming months.
Intuitive Surgical ($ISRG, Healthcare Equipment)
Intuitive Surgical is an established leader in the development, manufacture, and sale of robotic-assisted surgical systems. The firm’s “razor and blade” business model keeps its economic moat wide and switching costs high. After hospitals have paid an upfront cost to own or lease Intuitive’s flagship Da Vinci surgical system, they will continue to pay for servicing, complementary products (i.e. a new robotic head that can perform a different function, single-use accessories which are replaced on a per-surgery basis), and education/training. Intuitive’s ecosystem approach, where its robotic systems are accompanied by a full suite of accessories and services, means that even if a serious competitor entered the market, the switching costs for Intuitive’s customers remain high. Also of note is the firm’s strong balance sheet, with over $8 billion in cash and no debt as of the end of June 2022.
Intuitive currently trades at 47.54x earnings, down from over 60x at the end of last year, and quite high compared to other, more traditional, Healthcare names (see below).
Although Intuitive Surgical missed both top and bottom line estimates for its latest quarter, these shortcomings were largely due to lower procedure volume and supply chain disruptions caused by th COVID-19 resurgences of late. The confluence of these headwinds ameliorating and the propensity of surgical demand to be less sensitive to a high-rate environment are favorable tailwinds. From a growth perspective, Precedence Research estimates the global surgical robotics market size at $5.36 billion in 2021, projected to reach $21.3 billion by 2030; an impressive CAGR. This stock is part of Rauscher’s “Dunks stock list.
Regeneron ($REGN, Biotechnology)
This biotechnology company has 9 FDA approved treatments, and over 30 products in clinical development. Recent earnings beat Street forecasts, despite revenue and profits coming in lower than this time last year due to the phasing out of Regeneron’s COVID-19 antibody treatment, Regen-Cov. The core business (ex-Regen-Cov) saw continued strength in 2Q22, with record net product sales of Eylea, Dupixent, and Libtayo.
Regeneron’s extensive pipeline is balanced between phases 1, 2, and 3, and covers a wide range of therapeutic areas. The firm recently acquired Checkmate Pharmaceuticals, whose cancer treatment candidate is currently undergoing phase 2 clinical trials. Regeneron also recently completed the acquisition of Sanofi’s stake in Libtayo, granting them exclusive development, commercialization, and manufacturing rights to the treatment worldwide. With plenty of cash reserves, Regeneron could continue acquisitionsto diversify revenue streams in the face of new headwinds stemming from potential upcoming legislative hurdles. Direct Medicare negotiations are of particular importance to Regeneron, whose Eylea is one of the drugs Medicare spends the most on (almost $3 billion in 2019, see below).
Another potential risk to Regeneron’s revenue is the expiration of patents in 2025 and 2026 for its key drug, Eylea, approved for various ophthalmology indications. Typically, when a patent expires, more competitively priced generics enter the market, leading to a decrease in sales of the original treatment. Whether this will happen to Eylea remains to be seen. Other treatments currently exist in the wet macular degeneration market, but Eylea revenues remain strong, indicating a possible, but not definite, preference for Eylea among prescribing physicians.
Despite the expiration of Eylea patents, regulatory hurdles, and general pipeline risk, demand for medicine is inelastic, meaning pharma companies should maintain healthy margins, even in a slowdown. Furthermore, global demographics favor pharma plays, with one in five Americans projected to be over age 65 by 2030.
Abbott Laboratories ($ABT, Healthcare Equipment)
Abbott is a developer and manufacturer of a well-diversified set of healthcare products and services. Some of its main brands include Pedialyte, Similac, and PediaSure. The company’s revenue is spread across more than 160 countries with the United States comprising the most (38.6%) of its revenue by geographical segment.
Abbott posted a strong 2Q22 with $11.3B in sales showing continued strength in its well-diversified suite of products. This is not uncommon for the company as ABT has beaten Adj EPS 8/8 times over its most recent quarters by an average of 17.13%. The company raised its full-year EPS guidance to “at least $4.90,” a signal of strength despite the current shaky macroeconomic environment.
In terms of valuation, Abbott is richly valued, trading at 22x 12M forward EPS estimates of $4.97, but we believe the valuation is warranted given the strength of Abbott’s brands and several growth catalysts ahead. Medical device sales are expected to contribute an organic 3.4% of revenue growth in the coming year which should help drive the company’s top line. Additionally, Abbott’s management has guided conservatively despite continued high demand for COVID-19 self-test kits, a classic case of under-promising with the anticipation to overdeliver.
Abbott is a staple within the healthcare cohort and given our optimism regarding the sector’s outperformance in 2H 2022, we anticipate upside into year-end for the stock.